China’s ratings misprice its risk; Hong Kong’s are spot on

Disaggregating China’s investor risk into its constituent parts points to less safety in its sovereign bonds than its credit ratings suggest. Hong Kong is a different proposition with experts choosing to ignore its political problems.

On a total risk score of 61.08 out of a maximum 100 points,
China ranks 38th on Euromoney Country Risk’s
(ECR) global scoreboard, putting it towards the top of the
third of five tiered categories equivalent to a BB+ to A-
rating.

Its ranking has remained fairly stable in recent years, rising
two places compared with a year ago, but down one place since
the first quarter of this year.

Yet all three of the main agencies award a higher credit
rating, with Fitch putting China on A+, and
Moody’s and S&P agreeing on Aa3/AA-.

Five-year credit default swaps price in a lower risk of default
in China compared with Mexico, two places higher in
ECR’s rankings – with a spread of 77
basis points, compared with 83.

China’s ECR score has improved this year (by 1.2
points), but is still lower in comparison with 2010. All of
China’s economic and most of its political
risk-indicator scores have fallen during that time, reflecting
the weakened growth outlook.

Barring one or two positive surprises on the manufacturing
front, successive months of house price falls and other
'slowdown indicators’ have sparked another drive
to bolster liquidity.

Flemming Nielsen, senior analyst at the Danske Bank team taking
part in ECR’s survey, says: "In our view, we are
still in a phase of moderation in [Chinese] growth, driven by
weaker credit growth and investment demand. Hence, we still
expect the manufacturing PMIs to move lower in the coming
months."

Of the 15 risk indicators ECR’s panel of experts
are regularly asked to assess, China’s hard
infrastructure – one of four structural risk
sub-factors – scores highly, reflecting the
substantial public investment powering its economic
development.

However, China’s expansion has relied too much on
credit-driven investment and is showing signs of waning over
the medium term, requiring a faster pace of reform. Its
demographics and labour relations remain challenging –
the former in terms of longer-term welfare and state-pension
sustainability, which has yet to be properly addressed.

Low scores for corruption and transparency (hovering below 4.0
out of 10 points available) are unsurprising in that regard,
but highlight the risks for bank stability, which scores 5.2
out of 10 in the ECR survey, compared with 6.6 for Mexico, as
shadow-banking practices weigh on its risk profile.

The OECD attaches "great concern to the growth of illicit
local-government guaranteed debt", much of which is bank
borrowing by local government financing vehicles, and
officially estimated at Rmb20 trillion (40% of GDP) in 2012,
double the figure stated two years earlier.

Hong Kong a different proposition

Hong Kong, on the other hand, receives a score of 79.88,
placing it 12th on the global rankings, just inside tier one,
the highest ECR category denoting an AA ranking or above, in
line with Fitch (AA+), Moody’s (Aa1) and S&P
(AAA).

The special administrative region has received considerable
publicity in the light of Beijing’s interference
in its elections process for chief executive. Naturally, the
Communist Party wishes to promote a China-friendly candidate
for the post, but this has provoked considerable tensions, with
mass protests taking place both in favour of China and against,
in what has been dubbed a "David and Goliath" democracy
battle.

Slower growth on the mainland and across the wider southeast
Asia region would also be expected to deliver negatives for its
trade-driven economy.

However, Euromoney’s experts deem the risks of
government non-payment/non-repatriation to be extremely low in
Hong Kong (scoring 8.9 out of a maximum 10 points available), a
factor invariably linked to the high score for its government
finances (8.8 out of 10).

The territory has run a prudent budget surplus for six years
and is a strong net external creditor, with a current-account
surplus and fiscal reserves worth slightly more than a third of
GDP. With a strong and predictable currency board regime, all
of these factors should stand Hong Kong in good stead to
withstand any possible banking sector or real-estate-related
imbalances.

This article was originally published by ECR. To find out more,
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